First investment property since joining...financing???

Question

I plan to purchase my first single family rental this fall. I have realized that I need to buy CASH from a wholesaler, foreclosure, or stumble upon a great deal myself to even come close to my target rate of return (way north side of Houston). I plan to buy, rehab, and rent out. so....here are financing options. I will be using $15K to $20K of my own money.

Take a loan from (eek) Dad. I can probably get $70,000 @ %5 interest rate depending on his mood. He also won't have it available until later this fall. This comes with drawbacks. While he says he wants to be a silent investor and has had rental his hole life, i still get to hear him complain about having to pay taxes on his retirement withdraw to fund me. I would also plan to cash out refinance(which I'm not sure how that works/costs) to pay off as much of dads loan as I could. he would be ok leaving some money invested and providing him a return.

Tap the home equity?? I have no idea what the typical rules are with this. We currently owe about $240 on a home worth about $400,000. I would have to convince the wife to abandon the "Dave Ramsey" principles I have engrained in her. And would that even provide enough to work with?

I am very hesitant to use hard money. The costs seam to eat up a year of projected returns and any errors in my first attempt could really mess things up.

what would you do? thanks.

Mike

Mike Landry · Answer

thanks everyone. Gives me some things to think about. I don't want to take advantage of dad but also want the tax benefit of interest paid. Is there a way to structure a family loan so the interest can be written off as an expense. Also, is a heloc on home residence tax deductable the same as your mortgage or are the rules different. Thanks again.

Eric M. · Answer

@Mike Landry Personally, I think the Home Equity Loan or Line of Credit is the best choice of the options. HELOC is best if you want to use the money more fluidly, and a fixed home equity loan if not. You could get about $80k using the home equity line of credit. Right now, rates are good, and most banks will let you lock in a fixed rate on a certain amount. You would be an effective cash buyer with that amount. Plus, the HELOC gives you the likely tax advantages the loan from Dad would not. ;-)

Rocky V. · Answer

I take fully educated risk. I don't believe in overleveraging and the one key factor when purchasing a rental property in my opinion is cash flow. I invest in DFW and while some of my homes decreased in value (at least on paper) rents kept on climbing.

Steve B. · Answer

Rocky, if you used leverage in 2005 buying rentals you would likely be bankrupt in 2008. If you used leverage getting into the game in 2010 then you are a genius in 2014. The answer as to your "why not" is understanding the difference between systemic and non-systemic risk. Half the people on this forum extolling the wondrous benefits of leverage would be gone tomorrow if the housing market crashed. The point isn't not to use leverage, but rather to understand it's a calculated risk.

Jon Holdman · Answer

The basic strategy here is to buy a junker, fix it up, then refinance with a new appraisal. If you can add enough value you may be able to get most or all of your up front costs. I'm with your wife. I think its a bad idea to HELOC your residence to finance investments. I'm in somewhat of a minority opinion. But I think (and can do math to prove) that a residence is an expensive doo-dad, not an investment. Interest you pay on that expensive doo-dad is no different than interest on a car or boat. And, if you goal is to live off your investments its a lot easier to do if you have a free and clear house to live in. No way would I borrow from parents unless I was in dire straits. Especially if he has to pay taxes. If I did, I'd pay more than 5%. That's bank rate for mortgages, and private lenders will want more. I'd offer dad more like what a private lender would ask, probably 8-10%. Cash offers are stronger, but its not impossible to finance a deal with a wholesaler or foreclosure. Conventional loans will fund houses that need work. Portfolio lenders will be even more flexible. Try smaller banks or credit unions. You may need to work at saving up a bit more cash, but this is certainly the cheapest option.

Rocky V. · Answer

I would look into a Self-Directed IRA but you would need to abide by all rules. There are local credit unions in my area that will finance rentals with very favorable rates. Check your area. I too follow D Ramsey and I'm hesitate to tap into the equity of my home. That being said if you are confident in your numbers, "Why Not?". If I had followed his advise on buying rentals cash I would be far behind.

Katherine Conrad · Answer

@Mike Landry I too am new to the REI world here and am in a similar situation. Dad would be willing to loan me money. It makes sense in my brain to buy, flip, sell and repay Dad. What about a buy, flip, hold, rent? Do you refinance once it is rented to get the money out to repay the family loan? How much will they allow to re-fi?